Medicare HMOs: HCFA Could Promptly Reduce Excess Payments by Improving
Accuracy of County Payment Rates (Testimony, 02/27/97, GAO/T-HEHS-97-82).

GAO discussed the rates Medicare pays health maintenance organizations
(HMO) in its risk contract program, focusing on: (1) the Health Care
Financing Administration's (HCFA) method for setting HMO rates; and (2)
GAO's proposed modification of HCFA's HMO rate-setting method.

GAO noted that: (1) HCFA's current method of determining the county rate
produces excess payments; (2) because HCFA's method excludes HMO
enrollees' costs from estimates of the per-beneficiary average cost, it
bases county payment rates on the average per-beneficiary cost of only
those beneficiaries that remain in the fee-for-service sector and
ignores the costs HMO enrollees would have incurred if they had remained
in fee-for-service; (3) research has shown the costs of those remaining
in fee-for-service to be higher on average than the likely costs of HMO
enrollees; (4) a difficulty in correcting the problem is that HCFA
cannot directly observe the costs HMO enrollees would have incurred if
they had remained in the fee-for-service sector; (5) GAO's proposed
modification is designed to fix that problem; (6) GAO developed a way to
estimate HMO enrollees' expected fee-for-service costs using information
available to HCFA; and (7) GAO's approach produces a county rate that
represents the costs of all Medicare beneficiaries and could result in
hundreds of millions of dollars in savings to Medicare.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-HEHS-97-82
     TITLE:  Medicare HMOs: HCFA Could Promptly Reduce Excess Payments 
             by Improving Accuracy of County Payment Rates
      DATE:  02/27/97
   SUBJECT:  Health care programs
             Health insurance cost control
             Health maintenance organizations
             Statistical methods
             Overpayments
             Health care costs
             Medical information systems
             Health statistics
             Population statistics
             Medical economic analysis
IDENTIFIER:  Medicare Program
             Medicare Risk Contract Program
             
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Cover
================================================================ COVER


Before the Subcommittee on Health and Environment, Committee on
Commerce, House of Representatives

For Release on Delivery
Expected at 1:00 p.m.
Thursday, February 27, 1997

MEDICARE HMOS - HCFA COULD
PROMPTLY REDUCE EXCESS PAYMENTS BY
IMPROVING ACCURACY OF COUNTY
PAYMENT RATES

Statement of Jonathan Ratner, Associate Director
Health Financing and Systems
Health, Education, and Human Services Division

GAO/T-HEHS-97-82

GAO/HEHS-97-82T


(101545)


Abbreviations
=============================================================== ABBREV

  GAO - General Accounting Office
  HCFA - Health Care Financing Administration
  HMO - Health Maintenance Organization
  PPRC - Physician Payment Review Commission

MEDICARE HMOS:  HCFA COULD
PROMPTLY REDUCE EXCESS PAYMENTS BY
IMPROVING ACCURACY OF COUNTY
PAYMENT RATES
============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here today to discuss the rates Medicare pays
health maintenance organizations (HMO) in its risk contract program,
Medicare's principal managed care option.\1 As you know, Medicare's
method for paying risk contract HMOs was designed to save the program
5 percent of the costs for beneficiaries who enroll in HMOs. 
However, 10 years of research on Medicare's costs under HMOs has
found that the program's rate-setting method results in excess
payments to HMOs because HMO enrollees would have cost Medicare less
if they had stayed in the fee-for-service sector.\2

Recently, the Physician Payment Review Commission (PPRC) estimated
that annual excess payments to HMOs nationwide could total $2
billion.\3

A number of proposals have been made recently to help alleviate
Medicare's HMO payment problems.  For example, the proposed Balanced
Budget Act of 1995 called for, among other things, mechanisms to
lessen rate disparities across geographic areas and to decouple
annual HMO rate increases from annual fee-for-service spending
increases.  The administration's current budget proposal adopts
several provisions from the proposed Balanced Budget Act but also
adds new twists--such as an across-the-board reduction in Medicare's
HMO payments that would lower the payments from 95 percent to 90
percent of estimated fee-for-service costs.  Under the auspices of
the Health Care Financing Administration (HCFA), which administers
the Medicare program, several demonstration projects are planned or
under way, including efforts to improve risk adjustment and using a
process of competitive bidding to set rates. 

At the request of the Chairman, Subcommittee on Health, House
Committee on Ways and Means, we reviewed HCFA's method for setting
HMO rates to identify feasible options for promptly reducing the
amount of excess payments.  A comprehensive discussion of our work is
included in a forthcoming report.  In conducting our study, we
reviewed previous research on Medicare's HMO rate-setting method;
analyzed available HCFA data; and had our findings reviewed by
experts on HMO payment issues, including staff at PPRC and HCFA. 

Today, I would like to focus my comments on our proposed modification
to HCFA's HMO rate-setting method.  We believe this modification
could help reduce excess HMO payments under Medicare's current
payment method, the administration's method, or other methods that
rely on fee-for-service costs to set initial HMO rates or update
those rates.  Central to the current method and proposals for setting
HMO rates is an estimate of the average cost of serving Medicare
beneficiaries under fee-for-service in defined geographic areas
(currently, counties).  The actual rates paid HMOs for an enrollee
are set by adjusting these averages up or down on the basis of the
enrollee's "risk" of incurring higher or lower costs.  Considerable
attention has focused on the failure of current risk adjustment
methodology to adequately account for favorable selection, the term
used to describe the tendency of HMOs to attract a population of
Medicare seniors whose health costs are generally lower than those of
the average beneficiary.  Our work centers on the estimate of average
cost of serving a county's beneficiaries:  the county rate. 

In summary, we found that HCFA's current method of determining the
county rate produces excess payments.  Because HCFA's method excludes
HMO enrollees' costs from estimates of the per-beneficiary average
cost, it bases county payment rates on the average per-beneficiary
cost of only those beneficiaries that remain in the fee-for-service
sector and ignores the costs HMO enrollees would have incurred if
they had remained in fee-for-service.  Research has shown the costs
of those remaining in fee-for-service to be higher on average than
the likely costs of HMO enrollees.  A difficulty in correcting the
problem is that HCFA cannot directly observe the costs HMO enrollees
would have incurred if they had remained in the fee-for-service
sector.  Our proposed modification is designed to fix that problem. 
We developed a way to estimate HMO enrollees' expected
fee-for-service costs using information available to HCFA.  Our
approach produces a county rate that represents the costs of all
Medicare beneficiaries and could result in hundreds of millions of
dollars in savings to Medicare. 


--------------------
\1 Other Medicare managed care plans include cost contract HMOs and
health care prepayment plans, which together enroll fewer than 2
percent of the total Medicare population.  Because Medicare pays
these plans using methods other than capitation rates, they are not
the subject of this statement. 

\2 See the attached list of related GAO products. 

\3 This estimate was contained in material presented to the
Commissioners for their December 12-13, 1996, meeting. 


   HOW MEDICARE DETERMINES AN
   HMO'S PAYMENT RATE
---------------------------------------------------------- Chapter 0:1

Essentially, HCFA's calculation of its per-enrollee (capitation) rate
can be expressed as follows: 

Capitation rate = average per-beneficiary cost x .95 x
       risk adjustment factor

Medicare pays risk HMOs a fixed amount per enrollee--a capitation
rate--regardless of what each enrollee's care actually costs. 
Medicare law stipulates that the capitation rate be set at 95 percent
of the costs Medicare would have incurred for HMO enrollees if they
had remained in fee-for-service.\4 In implementing the law's
rate-setting provisions, HCFA estimates a county's average
per-beneficiary cost and multiplies the result by 0.95.\5

The product is the county adjusted average per capita cost rate.\6

HCFA then applies a risk-adjustment factor to the county rate.  Under
HCFA's risk-adjustment system, beneficiaries are sorted into groups
according to their demographic traits (age; sex; and Medicaid,
institutional, and working status).  HCFA calculates a risk factor
for each group--the group's average cost in relation to the cost of
all beneficiaries nationwide.  For example, in 1995 the risk factor
for younger seniors (65- to 70-year-old males) was .85, whereas for
older seniors (85-year-old or older males) it was 1.3.  HCFA uses the
risk factor to adjust the county rate, thereby raising or lowering
Medicare's per capita payment for each HMO enrollee, depending on the
individual's demographic characteristics. 


--------------------
\4 Section 1876(a)(4) of the Social Security Act (42 U.S.C. 
1395mm(a)(4) (1994)). 

\5 A 5-percent discount is taken on the premise that, compared with
fee-for-service care, managed care plans achieve certain
efficiencies.  For example, HMOs can negotiate with hospitals,
physicians, and other providers to obtain discounts on services and
supplies. 

\6 Medicare determines four capitation rates for each county, one
each for part A aged, part B aged, part A disabled, and part B
disabled. 


   MEDICARE'S HMO RATE-SETTING
   METHOD HAS LED TO EXCESS
   PAYMENTS
---------------------------------------------------------- Chapter 0:2

One reason the HMO rate-setting method overstates the expected
fee-for-service costs of HMO enrollees is that it uses only the cost
experience of fee-for-service beneficiaries.  If the health status of
the mix of beneficiaries enrolled by HMOs were the same as the health
status of those in fee-for-service, using fee-for-service
beneficiaries to estimate the expected fee-for-service costs of HMO
enrollees would be an appropriate method.  However, because research
has shown that HMOs have in general attracted healthier-than-average
beneficiaries, the beneficiaries remaining in fee-for-service
represent a sicker-than-average population.\7 This, in turn, means
that using data on fee-for-service beneficiaries exclusively produces
HMO payment rates higher than envisioned when the current rate
setting provisions were enacted. 

Medicare's risk adjustors explain about 3 percent of the variation in
individual-level health care costs and are thus not adequate to
account for the cost differences among beneficiaries.  The difficulty
is that, within the same demographic group, HMO enrollees are
healthier than fee-for-service beneficiaries; for example,
70-year-old males in HMOs are, on average, healthier than 70-year-old
males in fee-for-service.  Medicare's risk adjustor is said to be
inadequate because, while it makes broad distinctions among
beneficiaries of different age, sex, and other demographic
characteristics, it does not account for the significant health
differences among demographically identical beneficiaries.  The cost
implications of health status differences can be dramatic--for two
demographically alike beneficiaries, one may experience occasional
minor ailments while the other may suffer from a serious chronic
condition. 


--------------------
\7 HCFA's Health Care Financing Review, a 1996 study using
postdisenrollment data, estimated that HMO enrollees' costs were 12
percent lower than average, while a 1996 PPRC study using
preenrollment data estimated that enrollees' costs were 37 percent
lower than for comparable fee-for-service beneficiaries. 


   INCLUDING HMO ENROLLEES' COSTS
   IN COUNTY AVERAGE IMPROVES
   ACCURACY OF COUNTY RATES
---------------------------------------------------------- Chapter 0:3

Independent of improved risk adjustment, modifying the method for
calculating the county rate would help reduce Medicare's excess HMO
payments.  In setting county rates, HCFA currently estimates the
average Medicare costs of a county's beneficiaries using the costs of
only those beneficiaries in Medicare's fee-for-service sector.  This
method would be appropriate if the average health cost of
fee-for-service beneficiaries were the same as that of
demographically comparable HMO enrollees.  However, in counties where
there are cost disparities between Medicare's fee-for-service and HMO
enrollee populations, this method can either overstate the average
costs of all Medicare beneficiaries and lead to overpayment or
understate average costs and lead to underpayment.  Correcting this
problem is difficult because it is impossible to observe the costs
HMO enrollees would have incurred had they remained in the
fee-for-service sector.  Therefore, we developed a method to estimate
HMO enrollees' expected fee-for-service costs using information
available to HCFA.  Our method consists of two main steps: 

  -- First, we compute the average cost of demographically similar
     new HMO enrollees during the year before they enrolled--that is,
     while they were still in fee-for-service Medicare.  These
     fee-for-service costs are available through HCFA's claims data. 

  -- Next, we adjust this amount to reflect the expectation that a
     new enrollee's use of health services will, over time, rise.\8

Having completed these steps, we combine the result with an estimate
of the average cost of fee-for-service beneficiaries.  This new
average produces a county rate that reflects the costs of all
Medicare beneficiaries. 


--------------------
\8 Our analysis adjusts for (1) the tendency for enrollees' costs to
become more like--or "regress" toward--the fee-for-service cost mean
after joining an HMO and (2) the costs incurred by HMO enrollees who
die while enrolled.  How our method accounts for these costs is
discussed more thoroughly in our report. 


      SELECTED 1995 COUNTY RATES
      PRODUCED SUBSTANTIAL EXCESS
      PAYMENTS
-------------------------------------------------------- Chapter 0:3.1

To illustrate the effect of our approach, we analyzed data for
counties with different shares of beneficiaries enrolled in HMOs.  We
chose counties within a single state to eliminate variations
attributable to state differences.  We selected California because it
covers 36 percent of all Medicare HMO enrollees and includes counties
that in 1995 had the nation's highest HMO penetration rates.  We
found that our method could have reduced excess payments by more than
25 percent.  Although better risk adjustors could further reduce the
large remainder of excess payments, improvements to risk adjustment
require developing direct measures of health status, which is a
complex effort that may take years. 

The following key points also emerged from our analysis: 

  -- First, for the counties that we analyzed, we estimate that total
     excess payments in 1995 amounted to about $1 billion (of about
     $6 billion in total Medicare payments to risk HMOs in the
     state).  Applying our method for setting county rates would have
     reduced the excess by about $276 million. 

  -- Second, the excess payments attributable to inflated county
     rates were concentrated in 12 counties with large HMO enrollment
     and ranged from less than 1 percent to 6.6 percent of the
     counties' total HMO payments, representing between $200,000 and
     $135.3 million.\9 Despite the size of these amounts, the
     application of our method would have produced relatively small
     changes in the monthly, per-beneficiary capitation payments,
     ranging from $3 to $38. 

  -- Third, our analysis did not support the hypothesis, put forward
     by the HMO industry and others, that the excess payment problem
     will be mitigated as more beneficiaries enroll in Medicare
     managed care and HMOs progressively enroll a more expensive mix
     of beneficiaries.  Our data--which include counties with up to a
     39-percent HMO penetration--indicated that the disparity between
     Medicare rates and our rates is larger in counties with higher
     Medicare penetration.  For example, the four counties with the
     highest rates of excess payment in 1995, ranging from 5.1 to 6.6
     percent, were also among the counties with the highest
     enrollment rates. 


--------------------
\9 For the state's remaining 46 counties, excess payments
attributable to inflated county rates amounted to less than 3 percent
of the 58-county total. 


      DATA ARE AVAILABLE TO ENABLE
      HCFA TO PROMPTLY ADJUST
      COUNTY RATES
-------------------------------------------------------- Chapter 0:3.2

Because the data we used to estimate HMO enrollees' costs come from
data that HCFA compiles to update HMO rates each year, our method has
two important advantages.  First, HCFA's implementation of our
proposal could be achieved in a relatively short time.  The time
element is important, because the prompt implementation of our method
would avoid locking in a current methodological flaw that would
persist in any adopted changes to Medicare's HMO payment method that
continued to use current county rates as a baseline or
fee-for-service costs to set future rates.  Second, the availability
of the data would also make our proposal economical:  we believe that
the savings to be achieved from reducing county-rate excess payments
would be much greater than the administrative costs of implementing
the process. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 0:4

Medicare's HMO rate-setting problems have prevented it from realizing
the savings that were anticipated from enrolling beneficiaries in
capitated managed care plans.  In fact, enrolling more beneficiaries
in managed care could increase rather than lower Medicare
spending--unless Medicare's method of setting HMO rates is revised. 
Our method of calculating the county rate would have the effect of
reducing payments more for HMOs in counties with higher excess
payments and less for HMOs in counties with lower excess payments. 
In this way, our method represents a targeted approach to reducing
excess payments and could lower Medicare expenditures by at least
several hundred million dollars each year. 

Furthermore, our approach is useful under several possible scenarios,
including whether (1) the Congress adopts any proposal that uses
current county rates as a baseline, (2) HCFA develops and adopts
improved risk adjustors, or (3) the Congress and HCFA take no action,
thus preserving Medicare's current rate-setting process. 


-------------------------------------------------------- Chapter 0:4.1

Mr.  Chairman, this concludes my prepared statement.  I would be
pleased to answer any questions. 


   CONTRIBUTORS
---------------------------------------------------------- Chapter 0:5

For more information on this testimony, please call Jonathan Ratner,
Associate Director, on (202) 512-7107 or James C.  Cosgrove,
Assistant Director, on (202) 512-7029.  The analysis was conducted by
Scott L.  Smith, Project Director, and Richard M.  Lipinski, Project
Manager.  Other major contributors to this statement included Thomas
Dowdal and Hannah F.  Fein. 


RELATED GAO PRODUCTS
=========================================================== Appendix 1

Medicare HMOs:  Rapid Enrollment Growth Concentrated in Selected
States (GAO/HEHS-96-63, Jan.  18, 1996). 

Medicare Managed Care:  Growing Enrollment Adds Urgency to Fixing HMO
Payment Problem (GAO/HEHS-96-21, Nov.  8, 1995). 

Medicare:  Changes to HMO Rate Setting Method Are Needed to Reduce
Program Costs (GAO/HEHS-94-119, Sept.  2, 1994). 


*** End of document. ***